International Monetary Cooperation

On 1 January 2007, Bulgaria and Romania joined the EU, bringing the number of EU member states to 27. The euro area was also enlarged on 1 January 2007 when Slovenia became the first member state from the 2004 enlargement to adopt the euro. Another key issue in 2006 was the implementation of the Stability and Growth Pact after the reform in 2005. Since Cyprus and France have reduced their budget deficits to below 3 per cent of GDP, the excessive deficit procedure has been abrogated for these two member states. However, ten EU member states are still subject to the excessive deficit procedure. Four of these member states are expected to have reduced their budget deficits to below the 3-per-cent limit in 2006.

In the International Monetary Fund, IMF, the negotiations for a medium-term strategy took concrete form in 2006. The IMF's member countries have adopted a two-year programme for adjustment of the member countries' quotas, voice and representation. As an initial step, the quotas of China, Korea, Mexico and Turkey are raised to reflect these countries' stronger role in the world economy. In order to strengthen the macroeconomic and financial surveillance, multilateral consultations have been initiated. Finally, lending by the IMF has decreased substantially in the last 18 months, which has made it more urgent to ensure a sustainable income basis.

During the regular review of the Danish economy, the Article IV consultation, the IMF acknowledged the recent strong economic performance, but emphasised the risk of overheating. Furthermore, in conclusion of the Financial Sector Assessment Program, FSAP, the IMF overall found the Danish financial systems to be resilient and well-supervised.

ENLARGEMENT OF THE EU

Bulgaria and Romania are new EU member states
On 1 January 2007, Bulgaria and Romania joined the EU. This increased the EU's population by 30 million, which corresponds to approximately 6 per cent of its total population. The two new member states account for approximately 0.5 per cent of the EU's total output, and their level of prosperity is only around one third of the EU average.^[1] Bulgaria and Romania's level of prosperity is considerably below that of the new member states in the previous enlargement when they joined the EU in 2004. However, there is strong economic growth in both new member states, which is also reflected in high inflation rates and large current-account deficits.

In December 2004, the EU heads of state or government decided that Bulgaria and Romania could join the EU as from 2007, provided that they were considered ready by the European Commission, which was the case in the autumn of 2006. At the same time, Bulgaria and Romania were encouraged to strengthen their efforts in several areas, including reform of the judicial system, anti-corruption measures, veterinary and food safety, and administration of agricultural subsidies. The Commission can impose various sanctions in the event of insufficient progress in these areas.^[2]

Future enlargements of the EU
The three candidate countries Croatia, Turkey and the Former Yugoslav Republic of Macedonia (FYROM) are at various stages of the accession process. Accession negotiations with Croatia and Turkey were opened in October 2005, while no date has yet been set for the opening of accession negotiations with FYROM. The accession negotiations with Turkey and Croatia continued throughout 2006. The negotiations with Croatia in 2006 proceeded smoothly, while those with Turkey were more complicated. A slower reform process, concerns as regards freedom of speech and religion, and Turkey's barriers to the free mobility of goods were in focus during the negotiations with Turkey.^[3] 

Croatia is expected to become the next EU member state in view of the progress of the negotiations. However, the reformulation of the EU's enlargement strategy in December 2006 and the need for institutional reforms before further enlargement may delay Croatia's accession.

SLOVENIA JOINS THE EURO AREA

On 1 January 2007, Slovenia adopted the euro and became the 13th member of the euro area.^[4] Slovenia is thus the first new EU member state from the 2004 enlargement to join the euro area. Prior to a member state's joining the euro area, the European Commission and the ECB assess its compliance with the economic and legal conditions, i.e. the convergence criteria. Convergence reports are prepared at least every 2nd year, or at the request of a member state. In the spring of 2006, Slovenia and Lithuania requested a convergence assessment. Slovenia was found to meet the four economic convergence criteria concerning inflation, interest rates, government finances and participation in the EU's exchange-rate mechanism, ERM II. Lithuania met the criteria concerning interest rates, government finances and ERM II participation, but its inflation rate marginally exceeded the inflation criterion. On the basis of the assessments by the Commission and the ECB, the Ministers of Economic Affairs and Finance of the EU member states (the Ecofin Council) decided in July 2006 that Slovenia could adopt the euro on 1 January 2007. At the same time, the Ecofin Council decided that Lithuania could not adopt the euro from January 2007 as Lithuania's inflation was too high.^[5]

In December 2006, the other member states outside the euro area were subject to the regular convergence assessment. The exceptions were Denmark and the UK that have treaty-bound derogations and are therefore only assessed at their own request. None of the nine assessed member states met all convergence criteria.

During 2006 several non-euro area member states postponed their original target dates for adoption of the euro. Estonia and Lithuania had originally aimed to adopt the euro in 2007, Latvia in 2008 and the Czech Republic and Hungary in 2010. Their decisions to postpone were motivated by such factors as excessive inflation and in Hungary's case also a large budget deficit. In contrast, Cyprus, Malta and Slovakia have maintained their target dates for adoption of the euro. In February 2007 Cyprus and Malta requested convergence assessments with the objective of adopting the euro from 2008, while Slovakia aims to adopt the euro in 2009.

THE STABILITY AND GROWTH PACT

Experience so far with the 2005 reform
In the spring of 2005, the Ecofin Council^[6] adopted a reform of the Stability and Growth Pact.^[7] The objectives of the Pact are to contribute to preventing excessive deficits (preventive arm) and to set the framework for correction of existing excessive deficits (corrective arm). The 2005 reform was a compromise that was aimed mainly at strengthening the preventive elements of the Pact and increasing the flexibility of the corrective elements of the excessive deficit procedure, particularly in low-growth situations.

Since the reform of the Pact, several member states have been assessed under the excessive deficit procedure as a consequence of budget deficits in excess of the 3-per-cent limit. Experience so far has shown that the increased flexibility of the procedure has not adversely affected the objectives of the Stability and Growth Pact. Despite the expanded exemption provisions in the corrective arm of the Pact, neither low growth nor other factors, such as the implementation of structural reforms, were taken into account in the assessment of any member state's deficit exceeding the 3-per-cent limit. Instead, the increased flexibility was applied to determining deadlines and conditions for correction. In connection with the assessment of Germany's budget deficit in March 2006, Germany was thus given a deadline of two years instead of one. Thereby in 2006, Germany was given notice by the Ecofin Council to reduce the deficit to below the limit of 3 per cent, which is the last step in the excessive deficit procedure before sanctions may be imposed.^[8]

The EU member states' updated stability and convergence programmes from the turn of the year 2005/06 reflected the objective to strengthen the preventive arm of the Pact. This was expressed in the medium-term objectives for the budget balance that are based on the individual member states' government debt and estimated potential growth. Compliance with the objectives will give more leeway to handle the fiscal-policy challenges as a consequence of population ageing. Furthermore, the member states will be able to avoid tightening fiscal policy in bad times.

The budgetary situation in 2006 and the implications for the excessive deficit procedure
The EU member states improved their budgetary situations in 2006, supported by both the favourable cyclical position and the tightening of fiscal policy in several member states. The budget deficit for the euro area is expected to fall from 2.4 per cent of GDP in 2005 to 2 per cent in 2006. For the EU overall, a decrease from 2.3 per cent to 2 per cent is expected.^[9]

Cyprus is the only member state for which the excessive deficit procedure was abrogated in 2006 since in 2005 its budget deficit had already been reduced to well below the 3-per-cent limit. In January 2007, the Ecofin Council furthermore decided to abrogate the excessive deficit procedure for France after the European Commission's autumn forecast had confirmed the credibility and sustainability of France's reduction of its deficit to below the 3-per-cent limit in 2005, cf. Chart 27.^[10] The European Commission's autumn 2006 forecast predicts that in four of the ten member states that are still subject to the excessive deficit procedure, i.e. Germany, Greece, the UK and Malta, the deficit in 2006 will fall below the 3-per-cent limit. With the exception of Germany's 2007 deadline for correction of the excessive deficit, these member states have an obligation to ensure the necessary correction of their deficits in 2006.^[11]

Hungary is the EU member state with the largest budgetary problems. In 2005, Hungary's budget deficit was 7.8 per cent of GDP, and it is expected to increase to around 10 per cent of GDP in 2006. When Hungary updated its stability and convergence programme in the autumn of 2006 to include a plan for fiscal consolidation in the coming years, it was subject to assessment by the Ecofin Council under the excessive deficit procedure. Hungary was given another recommendation to correct its budget deficit to below the 3-per-cent limit, but the deadline for correction was extended from 2008 to 2009 in view of the extent of the required fiscal consolidation. At the end of 2006, the Ecofin Council decided that Poland had failed to implement sufficient measures to correct its deficit by the stipulated deadline of 2007. The Ecofin Council cannot implement the last step in the excessive deficit procedure and impose sanctions on Poland and Hungary since only euro area member states that do not take sufficient measures to correct a budget deficit exceeding 3 per cent of GDP can be subject to sanctions.

THE IMF's REFORM PROCESS RESULTS IN CHANGED VOTING WEIGHTS

In the International Monetary Fund, IMF, the negotiations on a medium-term strategy^[12] took concrete form in 2006, based on proposals submitted by Rodrigo de Rato, Managing Director of the IMF, in March 2006. The negotiations concern all IMF tasks relating to macroeconomic and financial surveillance, short-term balance-of-payments loans and technical assistance.^[13]

The IMF's Annual Meeting in Singapore in September 2006 focused especially on launching a reform process to increase the influence of the emerging economies and the poorest countries in the IMF, among other reasons because many more of these countries today play a significant role in the global economy. The member countries, including Denmark, approved an increase of the member contributions, or quotas, for China, Korea, Mexico and Turkey. The quota determines a country's voting power. This resolution thus recognises the stronger role of these countries in the global economy. The decision also signals forthcoming additional changes to the member countries' voting weights within the next two years, cf. Box 9.

ADJUSTMENT OF MEMBER COUNTRIES' VOTING WEIGHTS IN THE IMF	Box 9
In September 2006, the IMF's member countries, with 90.6 per cent of the votes, adopted a two-year programme for adjustment of the member countries' voting weights in the IMF. The voting weights are predominantly determined on the basis of each country's capital contribution, or quota. In the first instance, the quotas of China, Korea, Mexico and Turkey are raised since these countries were considered to be underrepresented in the IMF in terms of relevant measures such as the size and openness of their economies. The increase by 1.8 per cent in the total quotas raises these countries' overall voting weight from 5.4 per cent to 6.8 per cent. The voting weights of all other member countries will be equivalently reduced. Denmark's voting weight is thus reduced from 0.76 per cent to 0.753 per cent, cf. the Chart.
RESOLUTION ON ADJUSTMENT OF VOTING WEIGHTS
Note: At the end of February 2007 Mexico had not yet implemented the quota increase. The voting weights are calculated excluding the marginal change resulting from the quota increase of SDR 27.5 million that was granted to Montenegro when it joined the IMF on 18 January 2007. The Nordic-Baltic constituency consists of Denmark, Estonia, Finland, Iceland, Latvia, Lithuania, Norway and Sweden. See the description of the IMF's decision-making structure at www.nationalbanken.dk under Tasks/International cooperation/The IMF's decision-making process. Source: The IMF and own calculations.
This resolution also entails an adjustment of the calculation of the individual member countries' voting weights within the next two years. The calculation basis for the quotas and the quotas themselves are to be adjusted to reflect the member countries' role in the world economy more accurately. Furthermore, the resolution is aimed at improving the representation of the low-income countries in the IMF. This is difficult to achieve through quota adjustments since the economic progress of these countries typically lags behind that of the emerging economies and the industrialised countries. Instead, the IMF will increase the number of votes that are distributed equally among all countries, the basic votes, to enhance the voting power of the smallest economies. Finally, extra resources are allocated to members of the IMF's Executive Board with a particularly heavy workload. This is especially relevant for the two African constituencies that each comprise more than 20 countries.

FOCUS ON THE IMF's MACROECONOMIC AND FINANCIAL SURVEILLANCE

In 2006, the IMF as an element of its strategic development continued its efforts to improve the prevention of economic crises. The background is that the increasing integration of the economies has enhanced prosperity and given new opportunities, but also presented new risks, for example because economic and financial problems can spread more easily in a globalised world. The IMF will pursue this preventive strategy by stepping up the focus of its analyses and advice on:

• The relations between the policies in the individual countries and regions and the global economic development. A case in point is the influence of economic policy in China and the USA on the world economy.
• The relations between macroeconomic and financial policies. The financial sector is key to economic stability in the individual countries as well as globally because financial problems in one country can have a contagion effect on other countries.

A concrete example of the new initiatives is the multilateral consultations launched by the IMF in 2006. As an element of these consultations, the IMF holds meetings with the euro area, Japan, China, Saudi Arabia and the USA to discuss the global payment imbalances. The objective is for the IMF to play a larger role in the coordination of the countries' economic policies with a view to ensuring global economic and financial stability. Major countries, e.g. G7, support the multilateral consultations, and that they take place under the auspices of the IMF. The consultations have so far not entailed any specific measures, however.

The IMF's review of the Danish economy and the financial sector
In 2005-06 Denmark was reviewed under the voluntary Financial Sector Assessment Program, FSAP. FSAP is a review of the financial sector in order to assess the stability of a country's financial system. In general, the IMF has stepped up the surveillance of its member countries' financial sectors and financial markets in view of the financial systems' key role in ensuring economic stability. Since the financial crisis in Asia in 1997-98, the IMF has thus reviewed the financial sectors of more than 100 of its 185 member countries.

The IMF first considers the macroeconomic conditions and stress tests are performed. Stress tests are simulations used to examine how various types of hypothetical macroeconomic shocks might affect key financial institutions and thereby the entire financial system. In addition, it is assessed whether international standards for the financial sector are observed. In Denmark's case, its observance of standards for banking supervision, insurance, payment systems and securities settlement systems, and anti-money laundering and measures to combat financing of terrorism, was assessed.

The final FSAP meetings with the IMF were held in connection with the regular review of the Danish economy, the Article IV consultation. The IMF then completed a number of reports on Denmark that were published in October 2006 after consideration by the IMF's Executive Board.^[14]  

The IMF overall acknowledged Denmark's strong economic performance, including the importance of the fixed-exchange-rate policy, and supported the Welfare Reform. However, the IMF emphasised the risk of overheating. It is therefore vital that Denmark focuses on wage restraint, tight expenditure control and medium-term objectives focusing on sustainable government finances and rapid implementation of measures to increase the supply of labour.

In the context of FSAP, the IMF found Denmark's financial systems to be resilient and well-supervised. The IMF pointed out that sustaining the strong financial performance and stability requires support from macroeconomic policy and continued supervisory vigilance. Furthermore, the IMF stated that the housing market warrants close monitoring and effective consumer information about the risks involved in over-borrowing against real estate. The IMF made a number of recommendations, many of which are currently being implemented, cf. p. 69.^[15]

DECLINE IN THE IMF'S LENDING

The IMF's lending has decreased considerably in the last 18 months to the lowest level since the beginning of the 1970s. This can be attributed to such factors as recent years' favourable global economic development and financial conditions, with low interest rates. This has led to the repayment of IMF loans by large borrowers. It has also prevented new crises from arising. Since the summer of 2006, Indonesia, Uruguay and the Philippines have thus redeemed their IMF loans ahead of schedule for a total of SDR 6.2 billion (approximately kr. 53 billion). This is in addition to premature redemptions for SDR 23 billion from Russia, Brazil and Argentina since the beginning of 2005, and Turkey's redemption of half of its borrowing. At the end of 2006, loans to Turkey accounted for more than 70 per cent of the outstanding loans totalling SDR 9.8 billion, and the IMF's general borrowing programmes concerned only seven countries.

The reconstruction of the Turkish economy since the crisis in 2001 has continued, and the economic growth rate was approximately 5 per cent in 2006. Turkey has met the objective of a primary government budget surplus of 6.5 per cent, and inflation is under control. However, the deficit on the current account of the balance of payments reached approximately 8 per cent of GDP in 2006, and there is still a need for Turkey to strengthen its economic policy, accelerate its labour and product market reforms, implement bank reforms and modernise its social security system. Turkey was thus one of the countries whose exchange rate and equity prices were most affected by the turbulence in the international financial markets in May-June 2006.

The decrease in IMF lending has diminished the IMF's income basis since a large proportion of the IMF's administrative costs are financed via income from interest on IMF lending. In 2006, the IMF adopted temporary measures to offset the declining income basis by e.g. drawing on the IMF's reserves. Furthermore, the IMF established an investment account in order to achieve a higher return on its reserves. In 2007, the IMF will initiate discussion of more permanent measures to safeguard the income basis after a report by an external committee^[16]. The report's proposals include the investment of a proportion of the quota funds and the proceeds from the sale of a share of the IMF's gold stock, as well as expansion of the IMF's investment mandate.

The decrease in IMF lending is reflected in Danmarks Nationalbank's accounts with the IMF since the IMF finances its lending via currency contributed by the member countries, including Denmark, with a sufficiently sound foreign-exchange and reserve position. As IMF lending declines, there is less need for the IMF to draw on these creditors, hereby reducing their reserve positions.^[17] Denmark's reserve position is now less than 10 per cent of Denmark's IMF quota of SDR 1,642.8 million, cf. Chart 28 and Table 10.

The IMF's lending to low-income countries has also been reduced as a result of the Multilateral Debt Relief Initiative, MDRI^[18]. In principle, this initiative entails 100 per cent debt relief from the IMF, primarily for loans via the Poverty Reduction and Growth Facility, PRGF. At the end of 2006, a total of 23 countries had qualified for debt relief under MDRI since the initiative came into force in January 2006. In 2006, it was determined conclusively which countries would be entitled to debt relief under the Heavily Indebted Poor Countries facility, HICP, and MDRI. There are approximately 20 further candidates for debt relief, but the countries are subject to certain minimum requirements regarding macroeconomic policy, poverty reduction and government expenditure control.

The MDRI debt relief for the 23 countries is financed within the IMF's existing framework and not by the original lenders. In this connection, the government-guaranteed loan of SDR 100 million from Danmarks Nationalbank to PRGF was fully redeemed and no further drawing is possible.^[19]